Smes, Fdi and Capital Market Imperfections

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SMEs, FDI and capital market imperfections
Wouter De Maeseneire∗ Erasmus University Rotterdam, The Netherlands PO Box 1738 3000 DR Rotterdam The Netherlands Tel: +31 10 408 15 07 Fax: +31 10 408 91 65 email: Tine Claeys Vlerick Leuven Gent Management School Reep 1 9000 Ghent Belgium Tel: +32 9 2109773 Fax: +32 9 2109751 Email:

ABSTRACT This paper aims at exploring the problems experienced by SMEs in gaining access to debt and equity finance for FDI projects. We develop several hypotheses why SMEs are expected to face severe financing constraints for foreign investments and provide an empirical analysis of these issues for a sample of 33 Belgian SMEs. The market of FDI finance for SME is found to be subject to considerable capital market imperfections, which hinders small firms in their internationalization strategy and negatively affects their economic performance.

JEL classification codes: Keywords:

F21; F23; F34; G32; M13 small business financing; SMEs; FDI; internationalization; financing constraints

Corresponding author.

1. Introduction
A remarkable and extremely important business phenomenon of the 20th century was the internationalization of large and small as well as established and new venture firms (Sapienza, Autio, George and Zahra, 2005). Next to the fact that young and small firms increasingly tend to internationalize, another novel element of the globalisation trend has been the impressive rise in foreign direct investment (FDI). Yet, it is widely acknowledged that small and medium-sized enterprises (SMEs), in general, are subject to substantial financing constraints.1 In this paper, we hypothesize that SMEs that invest in foreign countries will face even more severe finance constraints. We argue that many of the financing difficulties are similar in nature as those experienced by firms that try to finance R&D projects: volatile returns, asymmetric information and a lack of collateral cause SMEs to have poor access to debt for their FDI projects. Moreover, financiers are likely to suffer from a home bias and the evaluation methods used by banks to assess these projects may present a further impediment to attracting finance. In the empirical section of this paper, we provide evidence of these hypothesized capital market imperfections for a sample of Belgian SMEs, and we examine whether they have a negative impact on these firms' growth and economic viability. Many countries spend substantial sums of public money to moderate equity and debt gaps that are assumed to be present, particularly among small firms. A wide range of policy schemes, such as direct loans, interest subsidies and loan guarantees, have been established to alleviate finance rationing of SMEs (Cressy, 1996; European Commission, 2003a). FDI credits for SMEs are available in several countries, which suggests the existence of a severe financing gap. However, apart from anecdotal evidence, there is little empirical verification of these alleged capital market imperfections.

Notwithstanding their huge relevance and economic importance, FDI financing decisions in SMEs have received comparatively little academic attention; moreover, little effort has

Financing constraints are present when a firm is not able to raise a sufficient amount of finance in time at a fair price that reflects the true risk of the project/company financed.



been spent to systematically analyze the potential lack of finance for FDI as one of the impediments for SMEs' performance and growth potential. Interest in large mature multinational firms as the unit of analysis dominates the international business literature (Oviatt and McDougall, 1994; Coviello and McAuley, 1999). Most research on internationalization does not focus on FDI but on other types of international activities, like export, or focus on internationalization problems experienced by specific companies, for instance high-tech...
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